How to Prepare Your MSME's Financials for the Year-End Audit | CFO Bridge

Year-end audits can often pose significant challenges for Micro, Small, and Medium Enterprises (MSME's). According to the Association of Certified Fraud Examiners, companies can lose up to 5% of their annual revenues to fraud, highlighting the importance of accurate and practical audits. Year-end audits for MSME's are a regulatory requirement, and it is crucial to ensure transparency, minimize financial risks, and comply with relevant tax and business regulations. 

This blog provides a step-by-step guide to year-end audit preparation for MSME's and explains how utilizing fractional CFO services can streamline the auditing process and enhance your company’s financial credibility. 

How Should You Prepare Your MSME's Financials for the Year-End Audit?

1. Know Your Audit Needs

Before approaching financial accounts, the initial action is to identify the particular audit requirements relevant to your MSME, depending on its turnover, constitutional structure, and activities.

a. Income Tax Audit Requirements

If your MSME's turnover exceeds ₹1 crore, it may be required to undergo a tax audit under the Income Tax Act. For MSME's with online transactions, the turnover limit for compulsory tax audits is raised to ₹5 crore. Tax audits are required unless the presumptive taxation scheme under Section 44AD is chosen. For turnover below ₹2 crore, 6% of the turnover can be reported as income without the need for a detailed audit.  

Action Steps:

• Check if your turnover is within the limit for the requirement of a tax audit. You can apply this to see if you can obtain a full tax audit or presumptive taxation.

• If you qualify, you can take advantage of presumptive taxation. This will simplify the audit process and filing by allowing you to report a fixed percentage of your turnover as income. 

• Be prepared to provide Form 3CD for the tax audit, as it is essential for capturing required information during the audit process. 

b. Statutory Audit under the Companies Act

If your MSME is a Company, it must get a statutory audit under the Companies Act 2013, regardless of turnover. The audit confirms the firm's financial statements as per law and promotes corporate governance and transparency.

Action Steps:

• Ensure your business has engaged a qualified statutory auditor to review your financial statements. 

• Prepare your financial statements by Schedule III of the Companies Act. Schedule III prescribes the format to present your financial statements and ensures they comply with statutory requirements.

c. GST Filing and Reconciliation

If your MSME GST - registered , GST compliance is essential. Ensure all GST requirements are met, including return filing and ITC reconciliation.

Action Steps:

• File the GSTR-1, GSTR-3B, and GSTR-9/9C returns within the prescribed time limits to escape penalties and continuously comply with GST legislation.

• Ensure ITC claims are reconciled with GSTR-2A or GSTR-2B submitted by the vendors. Reconciliation will assist you in ensuring your Input Tax Credit claims are correct and document-supported.

2. Preparation of Core Financial Statements

The basis of your year-end audit preparation is proper financial statements. These are the Balance Sheet, Profit & Loss, and Cash Flow Statement.

a. Balance Sheet

The Balance Sheet is a snapshot of your MSME's financial position at the end of the financial year. To set it up:

• Assets: Both current (cash, accounts receivable) and non-current (property, machinery) assets.

• Liabilities: Current liabilities (accounts payable, short-term loans) and non-current liabilities (long-term loans).

• Equity: Retained earnings and owner's capital.

Best Practices: Retain Schedule III compliance under the Companies Act for MSME businesses. Schedule III prescribes the classification of assets, liabilities, and equity and compiles your balance sheet statutory.

b. Profit & Loss Statement (P&L)

The Profit & Loss account highlights your MSME's performance by detailing the revenue and expenses for the year.

• Income: Sales revenue, interest revenue, and other operating revenue.

• Expenses: Cost of sales, wages, GST/taxes, and depreciation.

• Net Profit: Total revenues minus total expenses.

Best Practices:

• Accurately report depreciation, GST charges, and other allowances. They should be supported by adequate records and reconciled with your balance sheet.

• ​Ensure income statements from all departments are balanced, leaving no revenue unreported.. Cross-check the expenditure and income sources to ensure nothing has been left out.

c. Cash Flow Statement

The Cash Flow Statement is essential for assessing your business's liquidity. It tracks cash flows from operating, investing, and financing activities. 

• Operating Activities: Cash from company operations, including customer payments and supplier remittances. This section addresses the capability of the company to generate cash from its regular operations.

• Investing Activities: Cash inflow or outflow from selling or buying assets such as machinery. This component indicates the cash inflow or outflow from the company's investments.

• Financing Activities: Cash flow from lending, equity investments, or repayments. Financing Activities shows changes in your capital base, like debt and equity funding.

Best Practices:

• Reconcile bank statements to confirm that your cash balances agree with actual bank accounts. Doing so lets you determine any variance between your books and actual cash in the bank.

• Follow Accounting Standards (AS) 3 for presenting cash flow. This ensures that your statement follows standardized formats and is consistent with regulatory requirements.

3. GST Compliance and Reconciliation

Compliance is a must under GST, especially for MSME's. Variation in filing or claiming ITC would attract penalties.

a. GST Audit Checklist

• GSTIN Status: Your GSTIN must be active, and you may have to renew it. You cannot file returns or use ITC if your GSTIN is lapsed.

• Return Filing: File GSTR-1 (return of sales), GSTR-3B (monthly returns), and GSTR-9/9C (annual return) on time. Timely filing prevents late filing fees and interest charges.

• ITC Reconciliation: Reconcile the ITC claim with suppliers' GSTR-2A or GSTR-2B, as any inconsistencies may lead to queries from tax authorities.

Action Steps:

• Regularly follow up on delayed GST refunds, as delays can cause cash flow issues. Maintain regular contact with the government to address any concerns.  

• Ensure that e-invoices and e-way bills are accurate and up-to-date, as they are essential for validating your transactions in accordance with GST regulations. 

b. Common GST Issues

• Make sure all your suppliers have submitted their returns before you submit them for ITC. This is a typical situation where failure by the suppliers to file will disqualify you from input tax credits.

• E-invoicing is mandatory for businesses with a turnover exceeding ₹10 crore to streamline the process and improve transparency.

4. Tax Audit Readiness

MSME's have to prepare for tax audits by balancing their books as per the provisions of the Income Tax Act.

a. TDS Compliance

Tax Deducted at Source (TDS) is to be applied on different payments such as rent, payment to a contractor, etc. Reconcile TDS deducted and paid amount with Form 26AS and submit TDS returns as necessary.

Action Steps:

• File quarterly TDS returns in Form 24Q/26Q. These returns account for the TDS deducted and remitted by the business and are to be filed timely.

• Issue Form 16A to suppliers. This document contains a detailed report of the TDS deducted from supplier payments.

b. Presumptive Taxation (Section 44AD)

Under Section 44AD, if an eligible assessee declares profits lower than 8% (for cash) or 6% (for digital transactions) and does not maintain books or submit a tax audit report, they will lose eligibility for the presumptive taxation scheme for the next five years. This applies to MSME's with turnover up to the prescribed limit.

Action Steps:

• Verify if your organization can utilize presumptive taxation. If affirmative, you may account for a fixed percentage of your turnover as income.

• If choosing presumptive taxation, make sure to be Form 3CD compliant. This form comes with compulsory disclosures that must be filled in correctly.

5. Vendor Payment Compliance

Ensure your MSME complies with vendor payment regulations, especially if they are registered under the MSMED Act.

• 45-Day Payment Rule: Payments to MSME suppliers must be made within 45 days of the invoice date to avoid penalties. Timely payments are essential to comply with this rule.

• Disclosures: Provide disclosures of overdue dues to MSME suppliers in your accounts. This disclosure will provide transparency and legal compliance.

Action Steps:

• Verify your vendors' Udyam Registration Certificates to confirm they are registered MSME's and eligible for the 45-day payment facility. 

• Ensure accounts are cleared and all dues are paid on time. Proper vendor payment tracking helps maintain good relationships and ensures compliance with regulations.

6. Internal Controls to be Strengthened

Internal controls must be maintained to prevent fraud and errors in the audit process.

a. Inventory Audit

Perform a physical stock check to verify that book records match the actual inventory quantities. ​This identifies any discrepancies between recorded and physical stock.

Action Steps:

• Reconcile stock reports and physical inventory counts. This must be conducted regularly, especially before the audit, to prevent errors.

• Investigate discrepancies, if any, promptly. Discrepancies may indicate fraud, mismanagement, or clerical mistakes, which should be cleared before the audit.

b. Prevention of Frauds

Fraud prevention is a critical aspect of the audit process. To mitigate risks, internal controls such as segregation of duties should be implemented to prevent any individual from having excessive control over financial procedures.

Action Steps:

• Segregation of duties: Ensure varied staff members do the invoicing, payments, and reconciliation. Fraud and errors are prevented by it.

• Suspicious activity tracking: Use analytics to detect anomalies such as large cash withdrawals and unauthorized expenditures.

Insight: Utilizing cloud-based accounting technology to automate accounts and deliver live accuracy, ensuring the least margin for human errors. Fractional CFO services can implement the required technologies and integrate accounting systems to bring better scalability, security, and compliance.

7. Post-Audit Actions

After successfully completing the audit, consider the following steps:

• Audit Report Review: Carefully read the audit report to address any qualifications or comments from auditors. This will help any problems be sorted out promptly.

• Process Improvements: Improve as suggested by auditors for future audits. This can result in improved internal controls, compliance, and more streamlined financial processes.

• Completion of Financial Statements: Complete and sign the financial statements with the appropriate approvals. Such completed statements may be filed with the concerned authorities and stakeholders.

8. Continuous Monitoring and Enhancement

Audit preparation should not be a one-time task. Continuously monitor and improve your MSME's financials.

• Quarterly Reviews: Conduct quarterly reviews to identify discrepancies in financial statements. Regular monitoring ensures issues are addressed promptly.  

• Stay Current with Regulatory Changes: Monitor changes in tax laws and GST rules to maintain constant compliance. It will keep your MSME ahead of legal or regulatory changes that could affect its functioning.

Conclusion

Having your MSME's accounts ready for a year-end audit is essential not only for regulatory reasons but also to maintain the long-term financial well-being of your business. With proper planning, compliance requirements, and direction by fractional CFO services, MSME's can smoothly ride year-end audits without a glitch. By getting inspired by the suggestions provided in this blog and applying professional guidance, your business can have a hassle-free, smooth audit process that generates financial credibility and risk mitigation.